Kings and Queensland

Tuesday, January 11, 2011

Today, TMM was originally going to post their 2011 FX Non-Predictions, but the escalation in coverage of the Queensland floods and Belgian political situation has intervened and, instead, we decided to put down our thoughts on these issues.

So first, the Queensland Floods.

It seems to us that the market reaction here is very much like that to another national disaster several years ago. To set the scene, this particular country was in the process of a strong recovery out of a downturn a few years beforehand and its central bank was in the process of hiking rates from exceptionally low levels at a "measured pace", when all of a sudden a natural disaster struck. The country was, of course, the US, and the natural disaster was Hurricane Katrina. In response to the horrific TV images showing 85% of New Orleans underwater and real human tragedy, market participants began to argue that the hit to growth and consumer confidence would crush spending and the economy. As a result, the Fed would have to stop hiking rates - some even argued that they would *cut* rates.

The below chart shows the 12x15 Forward Rate Agreement (FRA, i.e. - a constant maturity ED4) back in 2005. Hurricane Katrina made landfall on the 23rd August, and by the 31st August/1st September, harrowing TV pictures showing the terrible conditions in New Orleans sparked a panic in the Rates market and risk-aversion more generally, with the front-end rallying around 40bps in just two days. In response to the deepening tragedy, the Senate passed a relief package on the 1st September, subsequently signed by President Bush the following day. As the flood waters subsided, and both the economic and corporate data came out on the strong side, the front-end of the curve retraced all of the move in less than a month, and went on to price in an even tighter hiking cycle... oh yeah, and the Fed continued to hike at its "measured pace", even hiking just a week or so after...

...Consumer Confidence collapsed in August, but rebounded very vigorously, along with other macroeconomic data...

...The spike in Food and Energy prices, along with raw materials costs due to rebuilding sent inflation higher...

...And the US went on to post as very vigorous +5.4% q/q GDP print in Q1 2006...

...And while construction employment peaked nationally around the same time, it continued to increase in Mississippi until 2008:

The point we are trying to make here is that the Queensland flooding is both (i) inflationary, and (ii) *net* growth positive. It is inflationary because not only is capacity (in the form of housing, offices, factories, mining equipment, cars and trucks) destroyed, but these also need to be rebuilt and replaced. And it is growth positive because not only do these need to be rebuilt and replaced, but there are usually state and/or federal relief packages which result in additional consumption and stimulus to the local economy.

Yesterday we mentioned that AUD was looking vulnerable in the short term on the combined Asia plus flood scene, but the scale of last nights market response has us thinking that the market has whipped itself into too much short term hysteria over the event and, not wishing to belittle at all the human tragedy of this horrific disaster, TMM reckon that the longer term outlook re floods makes the front-end of Australia now look like a massive "yours" and the Aussie Dollar a buy.

So what about Belgium?

TMM could not help but chuckle at the irony of the political crisis in Belgium resulting in the King assuming executive powers. It is 222 years since Louis XVI of France called the Estates Generale, putting into motion the gradual transformation from absolute Royal rule to parliamentary democracy. Yet it has taken the Belgians just 18months to fully reverse this, leaving the King and civil service to run the country, and the King has ordered a fiscal consolidation to take the deficit down to 4.1% of GDP. How about that for a lack of political squabbling? Indeed, the evidence from China would argue that in times of crisis, autocracy is a very efficient form of government.

Sir Humphrey Appleby in the BBC's "Yes Minister" once said: "Government is not about morality, it is about stability; keeping things going, preventing anarchy, stopping society falling to bits. Still being here tomorrow".

The point here is that the civil service has been running Belgium perfectly well for the past 18months, and there is now an executive (in the form of the King) directing the "correct" policy prescription to deal with the fiscal crisis. TMM would also make the point that the Belgians have not shown themselves to be shy from firing water cannon at disorderly protesters in the past. Extrapolating these developments further we look forward to France being ruled by the House of Bourbon and the next ECB president, far from being a "Weber", being a "Charlemagne" and Australia scrapping ANY plans for Republicanism with Shane Warne being made King, which would suit Ms Hurley.

Posted by cpmppi at 12:06 PM  


The US comparison is okay, but I think the Chile Earthquakes may offer a better parallel.

2:03 PM  

I guess you meant "mine" on the AUD rate, you want to lift the offer and be a payer at these levels. What maturity is best, 2y?

Anonymous said...
2:05 PM  

Thanks, I'd forgotten about that but yes, it probably is a bit more relevant given the export angle. An even more dramatic reversal then.

Well we meant "yours" the Bill futures or the 3yr bond future or, as you say, "mine" (pay) the 9m to 2yr part of the swap curve.

cpmppi said...
2:20 PM  

ok, I just checked and do not feel it's yet the time to "yours" at this stage, waiting for the forward curve to flatten completely

Anonymous said...
2:28 PM  

mmm the floods or the 45% spike in housing inventory

Anonymous said...
6:38 PM  

like i said yesterday, better off positioning for housing bust sometime in the nest 2 years through a basis trade than doing anything outright on the curve. if you are going to stick to rates that is.

Anonymous said...
6:48 PM  

I just spent a few weeks down in melbourne with family (my wife is from there). After witnessing the housing bubbles and busts in US, i would say there are many similarities, the major one being the heavy indebtedness of the Aussie household. However, they do have high income growth, a much more balance distribution of wealth, and inflation. Income growth and inflation are powerful tools to get you out of indebted situations. As far as actual house prices, I did some local homework and found what i thought was reasonable prices for home around melbourne. If aud was lower, it would look pretty cheap in usd. Prime beach property is cheap down on the great ocean road. I couldn't come close to buying anything with such beautiful views in the US so close to a metropolitan area as in the Aussie. Plus, with 20m people, they need more immigration to grow. Given the chance, there are literally millions in southeast asia would kill to live there. I was originally a buyer of the housing bust story in Australia, but now I think the story is less compelling.

7:20 PM  


Are there not literally millions who are willing to kill to live in US? If immigrants could prop up a housing market the Federal government could have simply granted all green card applicants green cards and voila...

Anonymous said...
10:49 PM  

Jonathan, I wouldn’t reappraise your views on the oz housing market solely on an experience in Melbourne. It has very affordable housing compared to the rest of oz and is probably not that frothy.
With the current exchange rate comparable houses in Sydney are way more than London but for me the greatest evidence of a bubble is the widespread use of “negative gearing” (negative yielding). OZ property investment relies on capital appreciation to break even and there is no shortage of locals that will argue property will double in value every ten years “because it always has done”
I’d also question the floods can be “net growth positive“. The size of the area, businesses and export industries that have been affected proportionate to the economy is not comparable.
It will be interesting to see how the RBA looks at the inflation impact
Anyway some views from “a very pleased cricket fan living down under”

PS TMM, loving you 2011 predictions!!!!

zen said...
1:06 AM  

I happen to like the Canterbury earthquake (believe it or not, the fifth most expensive earthquake of all time) as a parallel.

It affected almost a tenth of the population (think the entire state of Texas relative to the U.S.), and (relative to the size of the respective economies), will cost FOUR TIMES as much as hurricane Katrina to fix.

While there are expectations of increased economic activity (due to construction and such), it hasn't happened yet. The New Zealand economy has slowed, inflation has fallen, and the RBNZ has pushed back any OCR hikes until (according to the latest forecasts) the second half of this year.

Anonymous said...
9:41 AM  

I did hear a good argument today that the lost production from commodities would offset the growth impact due to new construction. Certainly some validity to that. And I agree, its bad economics to base my housing view on one urban area. If had shown up in Tennessee at the peak of the housing bubble in the US I would have never suspected there was one.

Also, I got a weird email from some guy stalking me because I used my real name to post a comment. How rude is that? Come on, don't hide behind anonymous.

10:35 PM  

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